Litigation

Directors Who Are Not Shareholders Cannot Sue Derivatively

By Francis G. X. Pileggi, Esq.

In Schoon v. Smith, (Del. Supr., Feb. 12, 2008), read opinion here, the Delaware Supreme Court ruled yesterday that a director qua director may not sue fellow directors of a corporation derivatively. This may sound esoteric for some, but any time the Delaware Supreme Court decides an issue that relates to the duties and/or rights of directors of a Delaware corporation, most serious students of corporate law and Delaware litigation pull up their socks and pay attention. Three prior decisions by the Chancery Court regarding litigation between (at least some of) the parties in this case were summarized here, here and here. 

 Fortunately for me, we have the benefit of a prompt and insightful comment on the case here, that comes to us courtesy of Steven M. Haas of Hunton and Williams LLP via the Harvard Corporate Governance Law Blog.

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

 

Full post as published by Delaware Corporate and Commercial Litigation Blog on February 13, 2008 (boomark / email).